1. a) What actions governments can take to affect the economy? b) What can be the consequences of government actions?
Two main regulatory macroeconomic policies are fiscal policy and monetary policy (1). Let's have a look at these policies:
Fiscal policy is basically the governments taxation and spending policy. When
government wants to stimulate economic growth, it is called expansionary policy.
Main tools of expansionary policy are:
-Reduced taxation
-Increased government spending
-Increased public dept
These
actions are taken in order to increase aggregate demand, and thus increase
economic activity, leading to higher inflation and increased employment. Here
are some possible effects of economic stimulation:
To fight inflation, a government can try to slow down economic growth. This is called contradictionary policy. Main tools for it are:
-Raising direct and indirect taxes
-Cutting government spending
Few politicians are eager to enact contradictionary fiscal policy, so this method is more commonly used by central banks.
"Monetary policy consists of the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates." (2) Central banks are government owned, so in practice the government has a say in monetary policy decisions.
The goal of a monetary policy is to control interest rate or inflation rate. This is most often done by modifying the supply of currency or fixing the exchange rate of the currency, or in extreme cases, devaluation.
The goal of a monetary policy is to control interest rate or inflation rate. This is most often done by modifying the supply of currency or fixing the exchange rate of the currency, or in extreme cases, devaluation.
Like fiscal
policy, there are two types of monetary policy: expansionary and
contractionary. Expansionary policy is used to stimulate inflation and economic
growth and contradictionary policy can be used to control high inflation.
Fiscal and monetary policies can be used simultaneously to affect economy.
The effects of these policies are not simply explained, and different economic theories have their own views on possible effects of these policies.
For example Keynesian economics believe that as prices are quite rigid it follows that if government spending increases, and all other factors of spending remain the same, then output will increase, thus increasing aggregate demand.
There's also a Keynesian theory, called multiplier effect - "output increases by a multiple of the original change in spending that caused it" (3) Which would mean, for example, that a million euro increase in government expenditure would cause output to rise 1,5 million euros (1,5 multiplier).
Please note that Keynesian theories have been widely disputed.
For example Keynesian economics believe that as prices are quite rigid it follows that if government spending increases, and all other factors of spending remain the same, then output will increase, thus increasing aggregate demand.
There's also a Keynesian theory, called multiplier effect - "output increases by a multiple of the original change in spending that caused it" (3) Which would mean, for example, that a million euro increase in government expenditure would cause output to rise 1,5 million euros (1,5 multiplier).
Please note that Keynesian theories have been widely disputed.
2. What are the external factors that affect government’s economic policy?
On a basic level external factors that affect government (economic) policy can be categorized as follows:
- Political factors
- Monetary unions, such as EU
- Wars
- Economic factors
- international interest rates
- fluctuations of other currencies
- Commodity price flutuations
- Environmental factors
- natural disasters
3. Why are governments subsidizing commodities?
In
Merriam-Webster's dictionary the word subsidizing is defined as 'to aid or promote
(as a private enterprise) with public money'. (4) This means, that for various
reasons governments give out tax payers money to industries they feel need
boosting. I will now have a look at some reasons why subsidizing is done.
At a basic level, governments are subsidizing commodities to avoid the share of imported commodities from rising. Another goal, especially in agriculture, is to keep the price level relatively low.
Picture from: http://subsidizinggreen.blogspot.fi/2011/11/micro-economics-role-of-government.html
http://ecopolistic.blogspot.fi/2012/10/smartphones-no-longer-want-but-need.html
Above are graphics of the supply + demand curve, and the effect of subsidies.
Country's economic structure has a lot to do with subsidizing policy. For example in poorer countries, where agriculture is the main employer, subsidizing farmers is not done as much as in more developed countries, where the population is moving to cities and abandoning farming. (5)
The benefits of subsidizing are widely argued. Some arguments against subsidizing are:
- subsidies are generally used well after the wanted results have been gotten, as political are hesitant to withdraw these benefits.
- It is claimed that subsidies are being directed at bigger, and already wealthier farmers and companies, and as such they do not bring out the wanted effects. (5)
References:
2. Investopedia http://www.investopedia.com/ask/answers/062315/what-purpose-issuing-contractionary-policy.asp
3. Blinder, A. The concise encyclopedia of economics, Keynesian economics http://www.econlib.org/library/Enc/KeynesianEconomics.html
4. http://www.merriam-webster.com/dictionary/subsidize
5. Sumner, D. The concise encyclopedia of economics. Agricultural Subsidy programs
http://www.econlib.org/library/Enc/KeynesianEconomics.html
5. Sumner, D. The concise encyclopedia of economics. Agricultural Subsidy programs
http://www.econlib.org/library/Enc/KeynesianEconomics.html
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